Redstate

I am very ill-schooled, and as such ill-informed, when it comes to matters of international high finance. I'm glad there are folks out there blogging this stuff in a manner that makes it palatable to us laypeople. (Read: us yokels.)

You're not alone. I barely understand what they're talking about. I do get the part about defaulting sub-primes though. The market pretty much made it's own bed with those INSANE lending practices like adjustable-rate and interest-only mortgages. And just the thought of government coming to the "rescue" is alarming indeed.

www.scottbomb.com
Click here to donate to the Fred Thompson campaign.

I have one myself, and I am hardly a sub-prime borrower.

This issue gets to the core of conservatism---should the government decide how much risk is too much risk? Should the government regulate/eliminate complex financial instruments like derivatives, shorts, options, etc.?

If you want to talk about the ease of losing money quickly that you don't have, try buying and selling derivatives on margin (e.g. borrowed money)! Now that is INSANE, and yet I wouldn't want any government rule preventing it.

Maybe someone is willing to devote every spare moment over several years of their life to build a business, buy a dream home, etc. Should that person be precluded just because 90% of the people without the same dedication would fail, resulting in a default?

Rescues should be out the question. If rescues are not presumed, the market will need to assess these risks accurately. There is a reason why someone with a less than awesome credit history pays more.

The problem is that the question you ask ("should the government decide how much risk is too much risk?") has already been asked and answered (affirmatively), during the New Deal. Our great-grandparents made the bed we now sleep in.

That argument can be used in favor of a lot of things Republicans oppose you know.

Hooray!

I didn't say I favor (your word) that outcome. I just said that it is what it is.

I can see some point in trying to change the settled political reality that most Americans believe the Federal Government has a positive responsibility to save them from harm and risk of all kinds. After all, we know that pigs can fly, given sufficient thrust.

It used to be inconceivable that the government would institute all sorts of things that we have now. The left didn't give up, though, and neither should we.

Hooray!

...on a conservative web site.

Here we go folks.

Wubbies World, MSgt, USAF (Retired):
public static void main(String[] args) {
System.out.println("An argument is a sequence of statements aimed at demonstrating the truth of an assertion.); }

It's going to be 5:00 somewhere by noon today.

Do you have a link showing current LIBOR pricing reaching 6%? I am only able to pull up rates as of the end of the day yesterday. A 0.5% increase as you say is staggering and has serious implications.

I don't doubt you that its happening, am just interested in seeing it for myself.

References a 5.86% overnight dollar-LIBOR. I had heard 6% from someone else earlier this morning.

Yikes- look out for the ripple effect now. Many of the recent LBOs were overleveraged and structured with very little margin for error. 50 basis point interest increase could pretty well eat into that minimal margin for error, which could lead to credit quality deterioration. Scary to imagine what the sitauation would be like right now (as bad as it is with still good underlying credit quality) with deteriorating credit quality....

Will be interesting to see where they all shake out, as well as Libor rates in the forward swap market.

(am out of the office today, so no access to Bloomberg. Darn!)

Fee based services do provide it.

I was running errands today, but some guys at the office were good enough to clue me in.

...of financial engineering. But two of the simplifying assumptions that portfolio analysts initially make are infinite liquidity and the availability of a benchmark risk-free credit.

The assumption of liquidity essentially means that you can get in and out of any sized position of a particular asset at any moment in time. (And that moment might practically not last more than a few milliseconds in today's computer-driven markets.) Because if you can't get in and out of a security whenever and however much you want, then the idea that the security has a value is just that: an idea, not a reality.

We know of course that none of this is perfectly true in practice, and there are mathematical ways to deal with that. But in overstressed times, not even rough estimates of liquidity are necessarily valid.

That introduces the (small) risk of a systemic panic where no one is quite sure what they own, and they'd rather be outside looking in than inside looking out.

In regard to risk-free credits: the asset class that most closely approximates this mathematical abstraction with generally high liquidity is US Treasury debt.

That's one of the reasons why I just shake my head in disbelief when people stand up here on RedState to say the the US government should engage in less deficit spending. You can't do that without undermining the basis of portfolio valuations.

that infinite liquidity and a benchmark valuation are necessary so that the functions used to price securites are continuous in all scenarios. That would make sense. If you solve a PDE that has singularities in the domain, every so often you step on one of those "landmine" points. I guess I'm too spoiled by our last 25 years of economic growth to consider what it would be like if we had another crash like 1929.

"Scott Thomas" - The New Republic's Winter Soldier

I'm not a mathematical economist myself, so this is the Cliff Notes version. It's kind of silly to suppose that any kind of solid science can be invented to "explain" financial markets, so all of this stuff is more empirical and heuristic in nature. (Just like global warming, of course, although the GW nuts won't accept that their stuff isn't strictly predictive.)

The simplifying assumptions are there mainly to make the models easier to use, and not to avoid mathematical phenomena like singularities.

Now I will say that it's currently a topic of some research interest whether or not the mathematical modeling of financial markets that is now widely practiced has in itself transformed the markets in structural ways. In other words, it's an open question now whether markets reflect reality, or whether reality reflects markets.

As recently as 25 years ago, that would have been considered a silly question. Milton Friedman, for one, never really trusted mathematical finance, just as Einstein never trusted quantum theory.

To your point about "singularities" leading to landmines: well, we know (because of the Long-Term case) that orderly markets become disorderly in extremely surprising ways. But again, the models are empirical. An absurd mathematical result isn't necessarily going to turn up in real life.

But the reverse is definitely true. The Long-Term debacle was "impossible" under all the financial models of the day. After Long-Term, everyone did everything they could to learn the lessons that were available to learn (daily or even multi-daily marks-to-market, for one thing). But the next debacle will be just as "impossible" under today's modeling as Long-Term was in 1998.

I love the line attributed to Keynes: "Markets can stay irrational longer than you can stay solvent."

infinite money in the bank? Correct me if I'm confusing terms but I understand that's what "liquidity" is supposed to mean in layman's terms - money in the bank.

I know wealth is something that grows and is not any sort of zero-sum, and I'm sure you're talking about theory more than practice. I wish I could experience infinite liquidity myself.

lesterblog.blogspot.com

In this case, the liquidity of a security basically measures how easy it is to trade it. It's not money in the back, its the general demand for the security in the market. A high liquidity security has a high demand, so it's always being traded. The infinite liquidity assumption means that there is basically an infinite demand (though not any specific price) for a security, so you can always find someone to buy the security from or sell the security to.

Thanks for that.

lesterblog.blogspot.com

When I replace that term with "Liquidate" from Mob histories.
It basically means how easy it is to get rid of and replace with Real Money.

"It's a book about a man who doesn't know he's about to die, and then dies...
...But if the man does know he's going to die and dies anyway. Dies, dies willing, knowing he can stop it, then...
Well, isn't that the type of man you want to keep alive?"
Karen Eiffel, Stranger Than Fiction

I agree with all of your analysis except the last part. And I do understand the concept of deficit spending during recession years vs. balanced/surplus budgets during the fatter years.

While I'm not advocating for higher taxes, I do think the psycological effect of the U.S. getting back to a balanced budget would outweigh the multiplier effect of the lost $200 billion or so in deficit spending.

My reasoning is in your next-to-last paragraph: "In regard to risk-free credits: the asset class that most closely approximates this mathematical abstraction with generally high liquidity is US Treasury debt."

If we have a situation where China is threatening to dump it's over $1 trillion in U.S. securities, it's going to be difficult to continue to roll over even exising debt, much less new debt. A balanced budget would signal the world financial markets that the U.S. is serious about maintaining our standing as the world's risk free investment house. It would enable us to deal with China one-on-one, as opposed to us against the world.

as spending. It's the issue of removing U.S. Treasury debt from the marketplace. U.S. Treasury debt is the standard approximation of a risk-free security in the market. If the treasury no longer issues debt, then there is no longer a security on the market to use to approximate the risk-free rate.

If we have a fully balanced budget, where spending is strictly less than tax revenue, the treasury no longer has to issue debt to finance the excess spending. Ideally, we draw down the debt to some eternally sustainable level and just keep issuing new debt to pay off the old, but the implied goal of a lot of people is to retire all U.S. Treasury debt without replacing it.

There's still roughly $9 trillion of national debt, most of which is financed by short term treasury notes. Though the treasury may eliminate certain types of securities (i.e., 30 year note), there's still more than enough debt already issued that constantly rolls over to make and quantify a market.

With U.S. Treasuries becoming more scarce, however, they become more valuable as a limited "risk free" investment. Their value goes up, interest rates come down, yada yada yada.

In the long term, of course, given that the political will to address these problems now is lacking, we'll have plenty of borrowing to go around.

It will be solved by inflation. Far easier, far more politically palatable.

I assume that they are including treasury debt payments in that, both interest on outstanding debt and payments to retire debt as it matures. As I noted, drawing down the level of outstanding treasury debt to some eternally sustainable level and then just letting it continually roll over would be a decent middle ground.

A balanced budget includes interest on the treasury notes, but not retiring maturing debt.

One of the ways the deficit was brought down during the Clinton years (in addition to cutting our number of troops in half) was to shift most of the treasury notes to very short term notes, which have lower interest rates. Our national debt is now financed like a really big adjustable rate credit card. We pay the interest (or issue new notes to cover it) and roll the balance every month.

There are also expenses that are sometimes placed "off budget". I believe that our war spending supplemental bills are off-budget, thus not considered part of the deficit, as an example.

only balanced after accounting tricks. I guess I should clarify that to read "...when someone says 'balanced budget' in the course of a more general discussion...' or something.

Rumors are flying about as I write (1PM EDT) that at least one Goldman Sachs hedge fund is trying to get liquid. These are the same rumors that flowed through yesterday afternoon about 3PM, that Goldman later denied. I can't tell you (because I don't know) whether these rumors relate to mortgage-backed securities.

As soon as there is a transaction, then everyone will have to mark their positions to market. And suddenly everyone who is severely underwater or under-reserved will be tempted to sell at once.

That's what an Air Force pilot would call "a bad day."

Ron Paul gives investment advice now? Here's a tip: buy AA... they make some really important stuff.
---
Underlying most arguments against the free market is a lack of belief in freedom itself. - Milton Friedman

A Bombay Sapphire and tonic would be about right.

Tell me again how Ron Paul's earmark for promoting "wild" shrimp would have fixed the sub-prime mortgage problems?

put him in your medicine cabinet today!

Are you saying that Ron Paul would use the force of the state, jack boots and all, to ban people from making shaky loans? Or just prevent people from investing in those who make them?

Or what, exactly, would Ron Paul to do change my investment portfolio?

Hooray!

...endorsement of Ron Paul, let me say this: I have not, do not, and will never support Ron Paul as a candidate for any office higher than assistant deputy mayor in charge of nose-picking.

Ron Paul has made some perceptive speeches in which he interprets the current fiat-money regime as an abrogation of a fundamental economic freedom, namely the right to own property with a value independent of the will of the government. He's arguably right about that.

Specie (metal) money would presumably fit Ron Paul's definition of an acceptable kind of money, but to my knowledge he's never endorsed a return to commodity money, nor has he explained how he would handle the overnight global depression that would result from such a move.

During the New Deal, the Federal Government made it illegal for American citizens to own commodity money. This was lifted during the Nixon years, but by then it was apparent that there wasn't nearly enough gold in the world to form the basis for the growing global economy.

That's more true than ever today.

ROn Paul may have voted against Gresham's Law, but some wacko economist got it reinserted into the budget as an earmark.

"Scott Thomas" - The New Republic's Winter Soldier

Gresham's Law only refers to systems that uses two or more forms of commodity money; such as our bimetallic system (think of the 19th Century). The Gold Standard Act of 1900 did away with our bimetallic system and replaced it with a unimetalic system. Therefore Gresham's Law does not apply to the US from 1900 to 1939 because we were under the Gold Standard during that era.

...a long habit of not thinking a thing wrong, gives it a superficial appearance of being right...

---Thomas Paine---

...but the US was never formally on a bimetallic standard in the late 19th century, though there was considerable political pressure to do so, particularly in the wake of the Panic of 1893. And everyone knows the "Cross of Gold" thing from the 1896 election. McKinley's election in that year (and his support by "Eastern interests," a code word for fixed-income investors on Wall Street), effectively put an end to the hopes of free silver coinage (and massive resulting inflation).

The US more or less resumed a formal gold standard in 1879, although dollars were continuously convertible throughout most of the 19th Century except during the Civil War.

Gold convertibility was suspended during World War I, a time which otherwise was remarkably orderly as regards international financial arrangements, even among belligerents.

Most of the world went back to a severely flawed gold standard after World War I (there were a few pockets of silver-standard, mostly in Asia), and as a result suffered nearly continuous financial crises throughout the Twenties.

Just about everyone abandoned gold convertibility around 1930 and started pulling out of the Depression. Except the United States. We persisted in maintaining gold convertibility at the early 19th century rate of $20.67/ounce until clean into 1934. This rate severely overvalued the dollar.

As a result, other countries (France in particular) traded us as many dollars as we would take in return for gold metal, in the early Thirties, causing a severe liquidity crisis in the US.

Then in 1934, Roosevelt finally changed the conversion rate to $35/ounce. This undervalued the dollar by about 40% at that time. Overnight, the gold started flowing back into the Treasury and the US recovery from the Depression accelerated.

The gold inflows lasted until 1940, when France fell to the Nazis, and resumed after WW2 until they again reversed in 1959.

And if you want to know why I remember all this useless trivia, well, my wife would like to know the same thing. :-(

I never used the words late 19th Century. I used the words "think of the 19th Century." I chose those words because a Bimetallic system was established by the Coinage Act of 1792, and it was maintained in some form or another through much of the 19th Century.

These sources all claim that a bimetallic system existed in the 19th Century US.
http://en.wikipedia.org/wiki/Bimetallism

http://www.referenceforbusiness.com/encyclopedia/For-Gol/Gold-Standard.h...

http://www.history.com/minisite.do?content_type=Minisite_Generic&content...

P.S. Are you describing the Bretton Woods system as a true Gold Standard?

...a long habit of not thinking a thing wrong, gives it a superficial appearance of being right...

---Thomas Paine---

You are correct that the 1939 date for the end of the Gold Standard in the US is wrong. I should have used a mid-1930's date for the end of the Gold Standard (sorry I went from memory on something that was ancillary to my point about Gresham's Law).

...a long habit of not thinking a thing wrong, gives it a superficial appearance of being right...

---Thomas Paine---

I know Ron Paul wants to abolish the Fed and reinstitute the gold standard, I just want this Ron Paulbot to come out and argue it directly, instead of coming in with rhetoric alone.

Hooray!

n/t

I took my Ron Paul donation and instead put it in a better place, some subprime.

Ask not what you can do for your country, ask what your country can do for you. Washington Elected Elite

The overnight spike was the weird one. Not unprecedented, but it definitely did reflect a short-term deterioration in market sentiment that Wall St. has totally followed through on (DJIA down 285 points as I write this, 3:25EDT).

What is Ron Paul going to do about interest rates after he abolsihes the Fed? The original purpose of the Fed was to prevent banks from loaning too much money, wasn't it?

Won't we just get more bad loans crashing down institutions under a Paul administration?

Hooray!

the federal government to stop banks from making bad loans. Or setting interest rates. As president, we can just expect him to veto everything, if he's sure the constitution even really allows that.

Wild Shrimp, anyone?

The sad part is, I'm the kind of guy who ought to be susceptible to arguments from Ron Paulbots.

They just go about it all the wrong way though... probably because so many of them are mobies that they just don't know how to reach out to true freedom lovers.

Hooray!

---
Underlying most arguments against the free market is a lack of belief in freedom itself. - Milton Friedman

First off, please use the Reply To This link when replying to somebody. It makes things easier to read for everyone.

Second, then if Ron Paul isnt' going to do squat about the economy, then why on earth do you say that people being hurt by this turn of events should support Ron Paul? Ron Paul won't have any effect on them!

Hooray!

Because Ron's policies would get this country back on the right track. Everyone would be better off if we got back to a sound monetary system. Fiat currency systems have all ended badly. That's where we are headed right now. The dollar is becoming worth less every day. This inflation tax hits the poor and middle class disproportionatly.

Allan Bartlett

Powder Blue Report

Well there, you came out and said it.

Ron Paul: End inflation and recession; bring back Depression and Panic!

Hooray!

Ah Neil, Ron Paul is not in charge now, George Bush is. It will be his depression when the stock & housing markets correct over 50% in the next year and a half and our dollar becomes worth half of what is is right now.

Allan Bartlett

Powder Blue Report

About the secret world government that is really running things... what with their black helicopters and that highway of doom they are building from Mexico to Canada.
---
Underlying most arguments against the free market is a lack of belief in freedom itself. - Milton Friedman

So you're on record predicting a depression next year?

Hooray!

But most people these days are actually financially solvent, whatever the media tries to tell us.
We won't suffer too greatly and the worst we can expect is a 70's style recession. Bad. But no major Depression.

"It's a book about a man who doesn't know he's about to die, and then dies...
...But if the man does know he's going to die and dies anyway. Dies, dies willing, knowing he can stop it, then...
Well, isn't that the type of man you want to keep alive?"
Karen Eiffel, Stranger Than Fiction

There's a lot of students and new graduates who are probably going to cry for a long time because of all the debt they have built up...

"It's a book about a man who doesn't know he's about to die, and then dies...
...But if the man does know he's going to die and dies anyway. Dies, dies willing, knowing he can stop it, then...
Well, isn't that the type of man you want to keep alive?"
Karen Eiffel, Stranger Than Fiction

Trying to start a Run, are we?

What a joke. It would take a Massive, physical disaster that wiped out huge pieces of our national economy to cause a 50% correction (er crash).

Ty 10%.

It'll hurt, yes. But we should recover in pretty short order (if Congress leaves the system alone) and we won't enter a Depression at all.

"It's a book about a man who doesn't know he's about to die, and then dies...
...But if the man does know he's going to die and dies anyway. Dies, dies willing, knowing he can stop it, then...
Well, isn't that the type of man you want to keep alive?"
Karen Eiffel, Stranger Than Fiction

First, an political site is not a proper place to give investment advice, especially advice linked to the fortunes of Ron Paul.

Markets go up. Markets go down. Always have, always will. Both events are reactions to underpricing and overpricing, respectively, in preceding markets.

We engage investment advisors to help us navigate the risks. Then there is the famous advice of one of the Rothschilds when asked how he became so wealthy: "I never bought at the bottom and always sold too early."

You're predicting a 50% drop in residential real estate and in the stock market. I never give investment advice on this site, so I can only respond in general terms.

I'd only expect a collapse like that (which would be the worst in American history) if we actually took Ron Paul's advice and went back to a commodity money standard.

Housing as a sector is considerably less valuable even than it appears to be, because the recent declines have frozen the transaction volume and made the market even less liquid than usual. (And residential real estate is illiquid in the best of times.)

But people don't face margin calls on their houses (except for the morons that took toxic-waste mortgages way beyond their means, and they'll get washed out pretty quickly). That means there will be no meltdown in housing. If things get really bad, the Fed will just create new money (they created about $24 billion today) and liquefy everyone. In general, moderately high inflation makes life easier for borrowers.

Something similar applies to the stock market. To the extent that a stock (imperfectly) approximates the value of the earnings of the underlying business, there probably is a floor under stock at some valuation level. That's because the domestic economy is moderately strong, and the global economy (which most large American companies are well-exposed to) is hot as a firecracker.

I understand that Ron Paul considers inflation to be theft. At some theoretical level, he has a point. But that's not the way the world works, not for the moment at any rate. At the end of the day, what matters is the total amount of economic activity, not the total amount of money.

And at some deep level, I think the American people understand this. That would explain why the savings rate (which everyone is in despair over) is so low: because it's irrational to save money in an inflationary environment.

aren't we? I'm surprised none of the replies caught you on it.

BTW, since you brought Jim Cramer into this, you might be surprised at these comments from the lifelong Democrat:

lesterblog.blogspot.com

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We are all heroes, you and Boo and I. Hamsters and rangers everywhere, rejoice!

50% correction? Don't kid me. Let's not forget this is all about people getting nervous. Fundamentally, there are relatively few problems; you'll loose money on mortgage foreclosings, but not the entire amount. At the end of the day that will topple some guys in the mortgage sector and some hedge funds, but major banks can handle that without much sweat. What is in fact causing all the ruckus now is that markets have extreme trouble trying to gauge who's in the doghouse and hence are reluctant to lend to anyone or trade risky assets. That's causing the liquidity crunch. At some point people will figure out where the trouble really lies, after which it is in everyone's interest to return to business as normal. Some repricing of certain risks will happen, some people will have their Bentley's repossed, but nothing truely fundamental.

Actually, there will be investors who at some point will start buying again even though liquidity is low and the fog hasn't cleared up completely, simply because the prices of various assets will be too low to resist. Easy money from the central banks (The European Central bank dumped almost 100 billion euros into the system yesterday, and that won't be the last of it) will help. And if you think that's a major inflation worry, think again: those are short term credits, which will be taken out of the market again before they reach your grocer.

I for one am planning to start buying some more stock if the markets go down much more.

The FED has been quite aggressive today. That may be calming some people's nerves. I've read that $B35 liquidity has been pumped in just today.

"Scott Thomas" - The New Republic's Winter Soldier